The economic calendar is important, featuring inflation data, two elements of the NBER “big four,” consumer confidence, and the JOLTS report. Those needing a fix of FedSpeak are out of luck since it is the quiet period for them. The data all point to an intersection between economic strength and the Fed. The question for stock investors will be: Should equity investors rely on the Fed to support stock prices?

Last Week Recap

In last week’s installment of WTWA, I expected a search for meaning in the conflicting market messages. I also predicted that developments on the imminent tariffs on Mexican trade would be our biggest “tell.” Markets certainly found a direction, but there is no consensus on meaning. No one really knows what to expect next.

The Story in One Chart

I always start my personal review of the week by looking at a great chart. This week I am featuring Jill Mislinski’s great combination of many important elements in a single chart.

The chart shows a gain 4.4% on the week. The trading range of 5.7% is higher than recent weekly results. The dramatic reversal this week highlights the news-driven trading. Our weekly Indicator Snapshot provides a handy history of both actual and implied volatility.

Noteworthy

If an index based upon implied volatility is your preferred measure for fear, you might want to compare stocks and bonds. Here is the Merrill Lynch MOVE index versus VIX, courtesy of The Daily Shot.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too.

New Deal Democrat’s high frequency indicators are an important part of our regular research. His long-term and nowcast indicators remain positive, while short-term is negative. He has provided his answer to our key question this week:

At the most basic level, higher interest rates last year, plus chaotic trade and tariff decisions, are causing near term metrics to be increasingly negative. But they are also leading to a cratering of interest rates and a surrender by the Fed to the need to lower those interest rates. The question for the economy going forward is, which force is more powerful?

The Good

The U.S. and Mexico reached agreement on a plan to avoid the imposition of tariffs. There was speculation about this during the week, but until Friday evening there was no confirmation from the President. Fox Newsdeclares it to be a victory for Trump’s approach. The New York Times reports that the immigration changes were agreed upon months earlier. Next week will provide some insight into how much of this was anticipated by financial markets. Part of the agreement was the Twitter promise, “Mexico has agreed to immediately begin buying large quantities of agricultural product” from the U.S. Since this was not a part of the joint declaration, it is something to watch in the coming week. The Wall Street Journal coverage also included this helpful graphic showing the large role Mexico plays in U.S. commodity imports.

• The Fed’s Beige Book showed continuing moderate economic growth in the reports from the various Fed districts. Steven Hansen (GEI) always has excellent coverage of this release. He carefully compares the narrative to prior periods and reminds of us terms used when the economy is entering a recession. This indicator was not helpful before the last two recessions!
• Light vehicle sales increased 5.9% month-over-month. Jill Mislinski provides an in-depth analysis with charts illustrating several approaches. This one shows a key theme.

• Initial jobless claims of 218K last week, equaled the prior month and slightly beat expectations of 220K. I am reporting this small beat in response to some good reader questions about this data series. Some have noted that the eligibility criteria were relaxed during the great recession, allowing a longer period of benefits. Many states have toughened up standards since then, which would reduce the number of continuing claims. Jill Mislinski provides an excellent update that provides a more informative slant. She looks at the claims as they relate to a growing labor force. This underscores the current record levels. Her post also shows continuing claims and the way both data series react during recessions. It is a great resource for those interested in this topic.

• ISM Services for May posted a reading of 56.9, beating both expectations of 55.4 and the April reading of 55.5. Here is an interesting chart showing the growing significance of services for the U.S. economy.

• Household Net Worth increased in Q1. Calculated Risk describes the regular Fed Flow of Funds report, combining helpful charts with some specific facts. The value of household real estate increased to $26.1 trillion in Q1. Over 30% of owner-occupied households have no mortgage debt. About two million homeowners still have negative equity.
• Sentiment is more bearish, widely regarded as a contrary signal. Bespoke has several charts, including this one:

The Bad

• ISM Manufacturing for May registered 52.1 versus 52.8 for April and missing forecasts of 52.6.
• Construction spending for April was flat, missing expectations for a 0.4% gain. March was revised higher, however, from a decline of -0.9% to an increase of 0.1%. This type of revision often affects the following month.
• Revenue and earnings declines for companies with significant global exposure. John Butters (FactSet) analyzed this differential. Brian Gilmartin takes a more comprehensive look at estimate changes, featuring the importance of the top 10 S&P stocks by market cap.

• ADP private employment for May increased 27K, missing expectations of 170K and the April gain of 271K. It was the biggest miss since 2008. Jill Mislinski has “a closer look.” 

• Nonfarm payrolls for May showed a gain of only 75K versus expectations of 180K. Not only was this below April’s 224K, but March and April were both revised lower by an amount totaling 75K. Everyone agrees that this was a big disappointment with respect to recent trends and expectations. How bad was it?

  • The Wall Street Journal opined that the report signals further slowing of growth calling it “a flashing yellow light that Mr. Trump needs to settle his trade wars and get back to promoting growth.

• Bob Dieli sees it as normal late-cycle volatility.

• Those emphasizing turning points to identify a weaker economy are taking a victory lap. New Deal Democrat was citing slowing growth in recent data even before Friday’s news. Eric Basmajian, who emphasizes the rate of deceleration (and maybe someday the rate of acceleration) cites a range of specific sectors and proprietary indicators to make his case.

The Ugly

The erosion of economic statistics. Timothy Taylor writes:

Economic statistics are invisible infrastructure, supporting better decisions by government, business, and individuals. But the fundamentals survey-based methods of US government statistics have substantially eroded, because people and firms have become less willing to fill out surveys in a timely and accurate way. There are active discussions underway about how to replace or supplement existing statistics with either administrative data from government programs or private-sector data. But these approaches have problems of their own.

He provides many sources and a nice history of how the need for key data dictated the development of many reports. He expects more detailed reports at longer intervals.

My own concern is the loss of key experts and the effect of budget cuts on needed equipment. Like so many other current problems, this is one where the effects are not obvious until it has become very costly to fix.

The Calendar

The calendar is another big one, including several important reports. Inflation reports are becoming more relevant than ever. Retail sales and industrial production are both expected to show significant rebounds. Consumer sentiment is expected to remain at high levels, despite the turmoil. And of course, the much-misunderstood JOLTS report will provide important information on possible labor market tightening.

There will be no FedSpeak, since we are now in the quiet period before the June meeting. But don’t worry about a lack of news. The Presidential candidate rhetoric and the Tweeter-in-Chief will provide plenty of action.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

Did last week’s trading clarify the chaos I discussed last week? Not really. The market rallied strongly, but the explanations are mixed and so is the prognosis. The main question seems to be: Should investors rely upon the Fed to support stocks?

Background

What you see depends upon where you sit.

• If you believe that the market leads the Fed, you have one viewpoint. If not, you may be more skeptical about depending on Fed action.
• If you think the economy is very weak, you are easily convinced by one set of arguments. If you see the decline as a normal reversion to economic trends, you are not so worried.
• If you think the trade issues will soon be resolved, you are confident. If not, the question is how much to worry.

Viewpoints

The Fed Surprises Markets

“Davidson” (via Todd Sullivan) writes Why Markets Don’t “Predict”…..Recession Fears Turn On A Dime. He explains how the combination of algorithms and media explanations, one of my regular themes, has created multiple recession scares in the last year and a half.

Barry Ritholtz, noting the market expectations of more aggressive rate cuts, cites Deutsche Bank economist Torsten Slok in showing the frequent errors in market predictions.

The Trade War is Adding Pressure

MarketBeat sees the impact on both the economy and the Fed.

The Fed Needs More Information

Bob Dieli is in this camp.

As is Fed guru Tim Duy, who writes, Fed Prepared to Adjust Policy As Needed. He also recognizes that The Fed May Have No Choice But to Bail Out Trump.

How Low Can Rates Go?

Bond bulls see a weak economy and low inflation taking the ten-year yield lower? A new record low of 1.25%? Some see it as possible. (MarketWatch).

I’ll describe some of my own expectations in today’s Final Thought.

Quant Corner and Risk Analysis

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.

With last week’s rally, the short-term technical health has improved to mildly bullish while the long-term remains neutral.

The C-Score declined along with the flattening yield curve, but not enough to alter the recession estimate. It still signals the need for watchfulness concerning confirmation from other indicators.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score”.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

Georg Vrba: Business cycle indicator and market timing tools. The most recent update of Georg’s business cycle index does not signal recession, nor does his unemployment rate method.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis, especially the regular updates of the Big Four indicators used by the NBER recession dating committee.

RecessionAlert: Strong quantitative indicators for both economic and market analysis. This week Dwaine takes up the interesting question,Is the U.S. Yield Curve Inversion locked in?
His analysis shows that when part of the curve inverts, the rest usually follow.

And herein lies a clue as to why this time things may be different – the ones above water and some of those already below water are actually widening their spreads! This could quite well shape up to be a false positive as witnessed in 1999 when only 60% of the treasury spectrum inverted.

Dwaine is well aware of the “this time is different” argument. He sees a yellow flag, but not yet a red one.

Guest Commentary

James Picerno is also interested in the yield curve. In the debate over which spread is best, he notes, Two Yield Spreads Are Better Than One For Business Cycle Analysis. He recommends looking at other supporting indicators, as do other business cycle experts. 

But to the extent that we look to the Treasury yield curve for insight, should we favor a particular maturity? More to the point, is the 10-year/2-year spread superior to the 10-year/3-month spread? In fact, history implies that using both spreads is an improvement over one or the other.

Consider the last three recessions, when both spreads went negative ahead of each contraction. By comparison, the two spreads are in conflict at the moment, based on rates as of yesterday (June 4) via daily data published by Treasury.gov.

BCA’s yield curve-based recession indicator, courtesy of The Daily Shot.

Insight for Traders

Our weekly “Stock Exchange” series examined three basic reactions traders were taking as they faced the increasing market volatility. Some of our own trading models went to the sidelines, waiting for a friendlier environment. By week’s end, all were back in the market. As always, our models provided some interesting stocks for discussion. Felix ranked the top choices in the S&P 500 and Oscar the most liquid ETFs. Pulling it all together was our series editor, Blue Harbinger.

Insight for Investors

Investors should understand and embrace volatility. They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely.

The day-to-day market is reflecting this pattern:

1. Algorithms have learned key words and respond to the news or tweet language.
2. Human traders pile on, perhaps taking the other side from the computers which are already cashing out.
3. The punditry, charged with imposing meaning on chaos, exaggerates the effect of minor news.
4. Mainstream media picks up these “reasons” as the story of the day, even if markets move modestly.
5. Investors who are observing casually become unduly frightened by the scary news and volatility.

Best of the Week

If I had to recommend a single, must-read article for this week, it would be Monevator’s Life expectancy for couples: why it’s surprisingly long and what you should do about it.
(This is one of the personal finance links this week from Abnormal Returns). Those familiar with probability will see the logic behind this table.

Using this approach, you can significantly improve your estimate of retirement needs, even in a time when “the probability of one member of a couple surviving to age 95 and 100 is increasing by 3% every five years.”

So individual life expectancies fly about as well as a paper aeroplane. Gambling your future security on a 50-50 bet of making age 95 won’t look smart if there are still bills to pay, your portfolio has waned, and you haven’t had the decency to fall off the log yet.

We need to settle upon a pragmatic degree of failure.

There is also a handy tool to assist your calculating, and information on your “safe withdrawal rate.” This article is conceptually simple, easy to apply, and extremely important.

Stock Ideas

Chuck Carnevale sees Target (TGT) as prospering, not just surviving. Check out his data-packed analysis and also get a lesson in stock-picking.

Kirk Spano advises watching for dips in finding sustainability investments.

John M. Mason likes JPMorgan Chase (JPM) which “has been moving to build more of a digital culture.” He was a day ahead of the Barron’s cover story calling JPM the leader in an attractive sector.

Andrew Hecht explains why U.S. Steel (X) is attractive in the face of recent declines. Should you play the long side with options as he suggests?

Interested in REITs? Sure Dividend likes both the yield and valuation for Simon Property Group (SPG). For another take check out the Behind the Idea podcast.

“Davidson” (via Todd Sullivan) likes CVSHealth (CVS). He notes synergies from the Aetna acquisition, insider buying, and a move to lower costs in healthcare delivery.

RoseNose updates her portfolio discussing both changes and the results so far in a difficult year. There are always good ideas in these posts – an honest and transparent account of the portfolio.

Ray Merola, admitting that his September 2018 recommendation has not worked well, updates his analysis of Schlumberger (SLB) – even cheaper, but no improvement in key metrics. When is it a bargain?

Tesla (TSLA)? Valuation guru Prof. Aswath Damodaran updates his analysis of Tesla. He provides plenty of data and you can download his spreadsheets to try your own hand at analysis. For the first time he finds the company to be slightly undervalued and would buy at $180. He wishes that Elon Musk would quit tweeting.

FedEx? Is the dividend at risk (Valuentum) or are China fears overblown (Ian Bezek). And just today FedEx announced that it will no longer provide express shipping for Amazon in the US (The FT). While this does not end the delivery to your home, it marks a change in the relationship.

Lyn Alden Schwartzer is also watching for a dip to buy in Rockwell automation (ROK). See the full analysis, including this highlight:

Rockwell is one of those companies that is very high quality and frequently fully-valued, and thus rarely found at a bargain. However, as an industrial provider, it is highly cyclical and tends to be more volatile than the broader S&P 500, meaning that every 5-10 years or so you can generally find it at an incredible bargain.

Personal Finance

Abnormal Returns always provides interesting ideas on a wide variety of topics. I am a subscriber, and I read it daily. Each Wednesday’s edition includes a post focused on personal finance. Of the many good articles, one is my choice for this week’s best (see above). I also especially liked Nick Maggiulli’s The Goldilocks Zone of Personal Finance. Drawing upon the work of David Owen, he suggests:

…what level of wealth you should strive for, or what I call The Goldilocks Zone of Personal Finance:  Enough money to have comfort, security, and motivation, but not so much that you add guilt, stress, or existential longing.It’s not too little and it’s not too much.It’s just right.

My challenge to you is to find and stay in your Goldilocks Zone.I can’t define exactly how much that is, since it varies from person to person, but I would wager that the amount is less than you think.

There is a lot to think about within this simple, well-stated concept.

See also Blair duQuesnay’s podcast on a similar theme. I really like the approach of adding timestamps for specific topics.

Watch out for…

• Apollo Investment Corp (AINV) despite the 11.3% yield. Achilles Research explains.
• Hindsight. Ben Carlson points out the Google’s stock is up 2000% from its IPO in 2004. It is so commonly used for so many purposes that this success now seems obvious. This is an interesting post, repeating some of the early warnings about the stock. “The past looks obvious but the future almost always looks messy. Many good ideas are only known with the benefit of hindsight.”

Final Thought

The Fed is still data dependent. There is a correlation between the market and Fed action because both are considering the same factors. In recent years the market has been more bearish on the economy while the Fed has been too bullish. The market record of forecasts is not good, nor is the Fed record in its own forecasts.

The implication is that the Fed cannot be counted upon to defend asset prices. We can expect action if economic weakness drops below the trend level, or inflation moves even lower. This week’s rally was sparked partly by those who believe asset prices are strictly a result of central bank policies. This is true only insofar as these policies have assisted corporate earnings and economic growth. I would not count on a Fed “put,” but neither do I anticipate an economic collapse.

The flip side is that tariffs are inflationary. While the immediate effect has been to lower growth estimates, prices, and interest rates, that will not last forever. I continue to monitor inflation data for signs if this change in impact.

The best news of the last week was not the Mexican agreement itself, but the process leading to it. The many voices of dissent within the Republican party, red states, Trump’s constituent groups, and big donors seem to have been heard. We knew this was taking place, but not that there was an effect. The agreement with Mexico is of questionable benefit beyond removing the negative tariff effects. The fact that it was accomplished may be a pattern for other trade issues, including those with China.

Attempting to guess the Fed’s next move is an impossible challenge. Traders continue to struggle with the volatility and hair-trigger changes. If you are a long-term investor, much of this action is merely noise.

And also, some longer-term items on my radar:

I’m more worried about:

• The declining hope for compromises. Each week it gets worse. This week featured more commentary from both Speaker Pelosi and the President. I am becoming more concerned about the upcoming budget and debt ceiling issues.
• The lack of progress on China trade issues. Most recently, Mnuchin is blaming China in the pre-G20 discussions. (NYT). It does appear, however, that Trump and Xi will meet at G20. (WSJ)

I’m less worried about

• Household debt. The scare stories never consider the asset side of the balance sheet. They never use a log scale. They never consider ability to service the debt.
• The newest gloomer issue – the lack of leadership by some stocks in the market. The rotation we are seeing away from FAANG is completely normal, but no one is paying attention. My post this week is a brief take, but extremely important. Can the Market Rally Without FAANG?